The ADBs role in encouraging and facilitating Asset Reconstruction Companies Dr. William Willms Prin

1
The ADBs role in encouraging and facilitating
Asset Reconstruction CompaniesDr. William
WillmsPrincipal Investment Officer, Asian
Development Bank6 November 2004
2
Introduction

• ADB Participating at early stage
• Public Sector Advising policy and framework
  dialogue, coordination and relationship
  management with Governments
• Private Sector Debt and Equity funding at early,
  riskier, stage
• ADB and India
• Public Sector TA on the SAFREASI Act and Secured
  Transactions
• Private Sector Equity funding for ARCs,
  potentially Security Receipt investor

3
NPL market drivers and the ADB

• INVESTMENT BANKS Principal business needs risk
  sharing
• Require leverage to lower equity cost, WACC
• Seek diverse partners to better share risks
• ASIAN NPL MARKETS Early-stage Development
• Early stage Fewer players, higher costs
• Later stage More standardization like other
  markets
• ADB Valuable Early-stage Participant
• Public Sector Provide political value as
  multilateral
• Private Sector Offer Debt and Equity funding at
  riskier early stage

4
Section 1 ADBs Role in NPL Resolution Projects
outside India
5
Overview

• MAIN Senior, limited-recourse debt
• Partial Credit Political Risk Guarantees
• Equity Participation at Early Stage
• General Comfort as Multilateral Partner

6
ADB Loan for NPL Portfolio Purchase

• Portfolio Acquisition Loan

• Senior, limited recourse
• Maximum of 25 of total transaction cost
  (funding) or US 75
• million (whichever is less)
• Full credit, market asset and legal due
  diligence
• Market-based spread
• Underwriting Fee of 1 - 1.5
• US, Euro or, depending on the country, local
  currency

7
Example Outright Sale
Investor
100
Debt
Portfolio
Originating Bank
SPV
Servicer
Fee
Purchase Price
Servicing
8
ADB and Securitization

• ADB Partial Credit Guarantee (PCG)

• timely payment of interest and ultimate payment
  of principal
• up to 100 of one tranche
• 2 shadow ratings by acceptable rating agency

• Liquidity Facility
• Political Risk Guarantee

9
Example Conventional CLOs

• Guarantee
• Loss bearing Liquidity Facility

Charitable Trust

• Senior Tranche
• rated bonds
• 1st priority security over Portfolio
• 5 years (callable after 3)
• Coupon Bearing
• Liquidity Facility from OECD Bank

Investors
100 equity
SPV
Outright sale of Portfolio

• Mezzanine Tranche
• unrated bonds
• 2nd priority security over Portfolio
• 7 years
• Coupon Bearing

Originating Bank
Investors
Market Value

• Junior Tranche
• bond/loan/preference shares
• subordinated
• 10 years
• zero coupon (cash sweep)

Originating Bank
Portfolio
10
Critical Issues The Servicer

• More than for any other asset class, the Servicer
  is critical for an NPL deal. There will not be
  any cash flow from the assets without a Servicer.
• Two kinds of Servicer
• Special Servicer
• Seller (Bank)
• Recovery Strategies
• Legal Proceedings
• DPOs (Discount Pay-Offs) or out-of-court
  settlements
• REO company, a third party that will go to
  auction if prices become too low with the purpose
  of selling the property on the open market
  afterwards
• Marketing Sale Programmes
• Funding Programmes, to provide funding to
  potential buyers of real estate properties (at
  auction or outside)
• Other Critical Issues Underlying asset pool
  (secured vs. unsecured), legal environment,
  structural enhancements

11
Section 2 ADBs Role in NPL Resolution in India
12
ADB and Indian ARCs
ARC
100
Trust
Sale of NPL
Originating Bank
SRs
SRs
Security Receipts (SRs) In consideration
Cash
Foreign Investor
Local Investor
13
THANK YOU
14
Appendix 1 Asias NPL Resolution Problem
15
New strategies in investment banking

• Moving away from client focus to principal
  business
• Ramping up proprietary business
• shrinking investment banking fees
• growing proprietary trading
• expanding distressed debt investment business
• example Goldman Sachss business model in Japan
• Growing advisory business in area of distressed
  assets
• continuous conflicts of interest to be managed

16
Equity Solution for Asian NPLs?

• NO. Equity is not sufficient.
• Magnitude of NPL problem in Asia
• Country limits and single deal exposures for
  investors
• Increasing sophistication from sellers (e.g. PRC
  AMCs) more complex bid/offer spread

Total Asia ex-Japan Distressed Debt
Distressed Debt to Stock Markets
in billions
Source Ernst Young Bloomberg
Source Ernst Young Bloomberg

• Approximately US815 billion of Asia
• ex-Japan NPLs

• Value of distressed debt is greater than some
  local stock markets

17
ADBs Involvement EARLY STAGE

• EARLY STAGE CATALYTIC
• Common Funder
• Strong benchmarks and transparent NPL market
• Best market practices
• Catalyzing debt funding from international and
  domestic banks

NPL Resolution Market
Number of Players
Fees
Market Development
t
(a) ADB
(b)
18
ADBs Market
Tiny Starting Growing Thailand
Philippines PRC
India
19
Appendix 2 ADB Due Diligence
20
Introduction

• NPLs can be classified into two categories
• Secured NPLs have a security a mortgage
  security or personal guarantee of good quality.
  In most cases, mortgage loans with a first-rank
  lien or loans with a corporate guarantee fall
  under this category. The recovery process will
  largely depend on legal proceedings, while the
  extent of the recovery will depend on the real
  estate market.
• Unsecured NPLs do not benefit from a good
  security. In most cases, mortgage loans with a
  second- or third-rank lien, unsecured corporate
  loans, consumer loans or overdrawn bank accounts
  fall under this category. The recovery process
  will largely depend on the efficiency of the
  servicer.
• The presence and the quality of a security for
  NPLs will obviously affect the expected level of
  recoveries for the creditor.
• NPL debtors are either private individuals or
  corporate legal entities (corporations in most
  cases). The debtors legal characteristics will
  affect the legal proceedings and their durations.

21
General Principles

• The Asset Side
• the characteristics of the NPL portfolio (secured
  vs. unsecured NPLs)
• the efficiency and the recovery strategies of the
  Servicer
• the eventual support mechanisms (Liquidity
  Facility/Guarantee in the case of payment
  shortfall on the NPLs)
• The Liabilities Side
• The waterfall of payments on the different
  classes of notes (subordination capital and/or
  interest)
• The eventual support mechanisms (collateral in
  the case of payment shortfalls on the notes)

22
Modeling Process
INPUTS on - assets
(recovery, timing) - support
mechanisms
OUTPUTS Expected Repayment Profile of ADB Debt
Modeling of Cash Flows Generated by NPL Portfolio
Cash Flow Model
23
Modeling Assets Cash Flows

• Assets Cash Flows Secured or Unsecured
• Secured NPLs Loan-by-Loan analysis
• Timing
• Type of legal proceedings (insolvency/bankruptcy
  or foreclosure)
• Phase of the legal proceedings and number of
  auctions according to the underlying real estate
  property.
• Court timing recovery according to the legal
  phase.
• Servicers strategy (legal proceedings or
  out-of-court settlements, or other strategies .)
• Amount
• Mortgage security amount
• Loan/claim Outstanding Amount (Gross Book Value)
  at the expected recovery date (legal interest or
  late payment interest)
• Forced Sale Value (minus legal fees) at the
  expected recovery date. The Forced Sale Value of
  the property is derived from the last Market
  Value and projections for the real estate market
  (according to the kind of property residential,
  commercial, industrial and the geographic
  situation)
• Several scenarios regarding timing (courts,
  Servicers efficiency/strategy) and real estate
  markets (cycles, volatility)

24
Appendix 3 Other Potential NPL Structures
25
(1) Joint Venture Management

• ADB Loans
• secured by Portfolio
• 5/7 to 10 years

Outright sale of Portfolio
Originating Bank
SPV
Debt Funding
Market Value
Equity Funding
50 Cash
50 In-Kind
Originating Bank
JV Partner
Portfolio
JV Agreement

• Compared to Holding the Portfolio, this solution
  provides
• Leverages the expertise resources of two JV
  Partners
• Lower upfront proceeds
• Medium up-front write-down
• Financing risk
• Maximum work-out upside / downside
• No deconsolidation

26
(2) Joint Venture with Pooling
25 Funding
Outright sale of Portfolio A
SPV
Bank A

• Senior Loan
• 1st priority security
• over Portfolios A B
• 5 to 7 years

Market Value

• Junior Loan A
• subordinated
• security over
• Portfolio A
• 7 to 10 years

• Junior Loan B
• subordinated
• security over
• Portfolio B
• 7 to 10 years

25 Funding
Bank B
Outright sale of Portfolio B
Bank B
Market Value
25 Funding
25 Funding
Bank A
Bank B
Portfolio
Joint Management Agreement
27
(3) Synthetic Sale
Senior Debt
1/3 Financial close
Originating Bank
SPV
1/3 1st year
1/3 2nd year
Equity
Investor
Market Value
Servicing Contract
- Base Fee - Incentive Fee
28
(4) Synthetic CLO with CDS
Charitable Trust
Guarantee
100 equity

• Senior Tranche
• rated bonds
• 1st priority security over Collateral
• 5 years (callable after 3)
• Coupon Bearing

Investors
CREDIT DEFAULT SWAP
SPV
Premium only
Funding
Originating Bank
No Credit Event Zero Credit Event Deliver
Asset reference price

• Mezzanine Tranche
• unrated bonds
• 2nd priority security over Collateral
• 7 years
• Coupon Bearing

Investors
Funding
Portfolio
29
(5) Hybrid CLO with Equity
Charitable Trust
Guarantee
7.5 of equity of SPV 1
100 of equity of SPV 2

• Senior Tranche
• rated bonds
• 1st priority security over Loan Receivables
• 5 years (callable after 3)
• Coupon bearing
• Liquidity Facility from OECD Bank

Investors
45 of equity of SPV 1
47.5 of equity of SPV 1
Originating Bank
SPV 2
SPV 1

• Mezzanine Tranche
• rated bonds
• 1st priority over 0 RW Assets
• 2nd priority security over Loan Receivables
• 7 year
• Coupon bearing

Investors
Originating Bank
Secured
Portfolio
Loan

• Junior Tranche
• bond/loan/preference shares
• subordinated
• 10 years
• zero coupon (cash sweep)

Originating Bank
Portfolio
30
William Willms Asian Development Bank 63 2 632
5469 wwillms_at_adb.org